LLC & Ownership Liability

History

In the 1970s, the business community saw the need for a new legal structure. They wanted a structure that had simple accounting and tax reporting requirements, as do partnerships and sole proprietorships. At the same time, they wanted the business to have the status of being its own entity, separate from the owner or owners, as is true for corporations. This would offer a level of personal protection, reducing the owners' liability for the debts and actions of the company. The state of Wyoming in 1977 was the first to enact the LLC statute.

One of the driving forces behind the popularity of the LLC structure is its ability to provide a layer of legal protection to the owner or owners, and to treat the business as a separate entity. In the event of debt or lawsuits, the owner's or owners' personal property and assets are generally protected from the obligations and activities of the LLC.

The Internal Revenue Service does not recognize LLCs as a business classification. Only sole proprietorships, partnerships and corporations are acceptable business classifications in the eyes of the IRS. Therefore, LLC owners must file their federal income tax returns choosing one of these classifications. When choosing a sole proprietorship classification, the LLC owner is responsible for all tax matters and must file a Form 1040 Schedule C, "Profit Or Loss From A Business". In partnership arrangements, all profit from the LLC is passed through to the owners. The partnership business pays not taxes itself. Each owner is liable for paying income tax on his share of profit from the business. Although the partnership LLC does not pay taxes, the owners must file Form 1065, "U.S. Return For Partnership Income". Classifying the LLC as a corporation requires the filing of Form 1120, "U.S. Corporation Income Tax Return," and both the business and the individual shareholders are liable for paying taxes. An "S" corporation must file Form 1120-S. An "S" corporation may be required to pay some tax, but generally the income is taxed to the shareholders, not the corporation. IRS Publication 3402 covers more information regarding LLCs and income taxes.

Although it is not required legally nor by the IRS, it is wise for an LLC business to draw up an "operating agreement." This document assists in proving the LLC is a separate entity from its sole proprietorship owner, resulting in less personal liability risk. In the case of a partnership LLC where there is more than one owner, an operating agreement can specify rules, guidelines and duties of the owners and how management affairs are to be handled. An operating agreement may help avoid conflicts that could come up at a later date.